What are the Secrets to Inditex’s Success?

The Ukraine war led to a very difficult 2022 for fashion retailers. The loss of the Russian market, where European retailers enjoyed VAT benefits and favourable pricing conditions, weighed on their margins. More importantly, the war triggered an unprecedented surge in the cost of living in the Western world, forcing consumers to forget about their wardrobes in the face of high energy bills and food expenses. 
Benefiting from its unique business model, Inditex has maintained spectacular double-digit sales growth and strong margins amidst a wave of profit warnings from industry rivals. The group’s gross margin reached its highest level in ten years at the end of April. 
Inditex has outperformed the sector and will continue to outperform its peers, despite the uncertain trading environment for the year ahead. Inditex is the best-performing fashion company in our apparel, textile and fashion equity research universe.
  
 
Inditex’s Stock performance

Industry-leading inventory management 
Supply chain disruptions in late 2021 dealt a blow to sales growth for most sporting goods and fashion retailers. Consumers’ desire to reward themselves after two years of pandemic and warmer weather in the spring of 2022 delayed an expected contraction in discretionary spending, which encouraged retailer confidence in demand. European fashion retailers increased their inventories in early H2 22 in the face of unpredictable supply chain tensions.  
However, as the cost of living continued to soar and heating needs wiped out discretionary $, the non-essential retail sector began to soften. Piling up inventories and softer demand for the autumn/winter season have led to higher markdowns in the post-season, which affected retailers’ gross margins. 
Inditex’s unique business model (>50% production/sourcing from neighbouring countries) allows the group to operate with the lowest inventory levels in the industry. 

As shown in the chart below, Inditex exceptionally increased its inventory levels significantly in the summer of 2022. While Inditex has to date maintained double-digit sales growth, the evolution of inventory levels has remained broadly in line with the revenue trend (total sales in constant currency between 1 November and 8 December 2022 increased by 12% yoy. Inventory levels on 8 December 2022 were 15% higher than the same period last year, compared with 27% on 31 October 2022). 
 
 
 
 
A more diversified brand portfolio 
Inditex also has a unique pricing policy. It decides on a price before designing the product, and then sources and finds the materials to manufacture it at the determined price. This policy guarantees stable margins and reduces dependence on certain raw materials. 
Faced with the ongoing rise in input costs, Inditex has increased the prices of a selection of products by mid-single digits. Not only have these selective price hikes not affected sales volumes while maintaining margins, they have also increased the image of some high-end products.  
 
 
 
 
Indeed, under unprecedented inflationary pressure, consumer trends in the US and Europe have begun to diverge, with lower-income consumers tightening their wallets further, while higher-income consumers continue to increase their spending on high-end products. High-end brands Zara and Massimo Dutti and more affordable brands Pull&Bear and Stradivarius both saw encouraging growth in 2022. We believe that Inditex has taken advantage of price adjustments to expand its presence at the high end of the market while ensuring traffic for the affordable brands. 
 
Impressive margin trajectory 
So far, Inditex has maintained double-digit revenue growth and a strong gross margin despite a very challenging business environment in 2022. As shown in the chart below, Inditex has outperformed H&M in terms of gross margin, thanks to its flexible supply chain (>50% production/sourcing in neighbouring countries), optimal inventory management and a more balanced brand portfolio. 
 
 
  
Best-in-class fashion retailer 
We believe that the current inflationary environment will continue to weigh on the consumer environment in the Western world at least until the first half of 2023. Weak demand and rising inventory levels will continue to weigh on fashion retailers’ results through 2023. 
Its flexible, demand-driven supply chain, impressive inventory management and improved pricing power will make Inditex more resilient in the current environment.